Rules vs. Discretion in Organizations

18 Pages Posted: 14 Apr 2015

See all articles by Susheng Wang

Susheng Wang

Hong Kong University of Science & Technology (HKUST) - Department of Economics; Shanghai University - SHU-UTS SILC Business School

Date Written: April 13, 2015

Abstract

Whether to set managerial rules or allow managerial discretion is a key issue in organizations. In this paper, we investigate the boundaries between rules and discretion in the firm. Using an incomplete contract approach, we differentiate between projects that are more efficiently managed under rules and those that are more efficiently managed under discretion. Our main finding is that for conservative projects with low expenditures and balanced expenditure/quality ratios, rules are more efficient than discretion; for other projects, discretion is efficient. We also find that (1) rules offer better incentives; (2) discretion works better for risky projects; (3) whenever discretion is efficient, rules are equally efficient; and (4) the profit share to the manager is independent of her decision-making rights (separation of income and control rights).

Keywords: managerial rules, managerial discretion, organizations, incomplete contracts

JEL Classification: M16, L23

Suggested Citation

Wang, Susheng, Rules vs. Discretion in Organizations (April 13, 2015). Available at SSRN: https://ssrn.com/abstract=2593942 or http://dx.doi.org/10.2139/ssrn.2593942

Susheng Wang (Contact Author)

Hong Kong University of Science & Technology (HKUST) - Department of Economics ( email )

Hong Kong
China

Shanghai University - SHU-UTS SILC Business School ( email )

Shanghai
China

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